Hotels/Restaurants/Casinos

Yum struggles in China as novelty fades

LaurieBurkitt

Yum Brands Inc., which gets around half its revenue from China, is facing a new reality: Chinese consumers who once found its KFC and Pizza Hut chains fresh and different now see them as neither.

Yum Brands is set to report first-quarter results after the U.S. market close on Tuesday. Some analysts expect it to post weak sales as it struggles to overcome setbacks in China. In the fiscal fourth quarter of 2014, Yum's China sales were down 12% from a year earlier, to $2 billion, and followed a decline in the third quarter.

Novelty was a big draw for Chinese customers when Pizza Hut and KFC--along with other American brands such as McDonald's and Wal-Mart--swept into China in the late 1980s and '90s. Decades down the line, these brands face customer defections to newer rivals.

Liu Yue, a 30-year-old finance worker who began eating at Pizza Hut several years ago, this weekend tried out a newly opened Pizza Express in one of Beijing's hottest shopping centers instead of going to the nearby Pizza Hut.

Pizza Express, originally a U.K. chain that Chinese private-equity firm Hony Capital acquired last year, sells pizzas for 80 yuan to 135 yuan, or from $13 to a whopping $22, including one with spicy Italian sausage and marscapone and fennel seeds, with chefs tossing the dough in view of customers.

Yum Brands promoted Pizza Hut in China by offering food far beyond pizza, such as fried Chinese rice dishes and French steak. That approach led to some baffling menu items, such as a pizza sold two years ago that had 24 Milanese sausages baked into the crust, circling a pie topped with squid, crab, fried shrimp and a mayonnaise drizzle

It is a recipe for success that may have run its course with some consumers.

"Pizza Hut sells food they think Chinese will like, not authentic food," said a 27-year-old government employee who gave only her surname, Liu.

Sales at Chinese Pizza Hut stores open more than a year declined 9% in the fourth quarter.

Pizza Hut's travails are emblematic of the brands that arrived early in China but are losing cachet.

In 2012, 39% of consumers in China surveyed by market-research firm Millward Brown called McDonald's a desirable brand, while a third said the same of Pizza Hut. In a survey last year, that had dropped to less than a quarter for both brands.

Some domestic dining chains have also eaten into the U.S. brands' turf. China's Xiabuxiabu Catering Management Holdings Co. serves hot pot--a broth in which customers cook their own meat and vegetables--at a price that competes with Pizza Hut's 88 yuan black-pepper-beef-fajita dish. Xiabuxiabu, which listed its shares in Hong Kong last year, aims to double the number of its stores to 1,000 in the next four years, rivaling Pizza Hut's count.

Yum declined to comment on customer defections.

Yum Brands, based in Louisville, Ky., has seen the writing on the wall for a while. "It's true, we're not [new] anymore," said Yum's China chief Sam Su in an interview in 2013.

To win consumers looking for a more upscale experience, Yum Brands is opening a high-end Italian eatery in Shanghai, Atto Primo, by the end of April, said a China-based spokeswoman for Yum. In the Bund area along Shanghai's Huangpu River, Yum will sell pasta dishes in the $25 range as well as Wagyu steak for 298 yuan, roughly $50, well above the 35 yuan spaghetti it sells at its Pizza Huts in China.

For now, Atto Primo appears little more than an experiment. Yum has "no future plans other than to see how this performs with consumers," the spokeswoman said, adding that Atto Primo "may serve as an innovation lab for Pizza Hut."

Meanwhile, KFC, the first Yum Brand chain to enter China, in 1987, is facing an even worse loss of appeal. Only 19% of respondents called it a desirable brand, down from 42% in 2012, according to the Millward Brown survey, while a quarter view it as "different," compared with 42% in 2012.

KFC has faced other setbacks in the market. Chinese media reports last summer connected KFC with a restaurant supplier that allegedly sold expired meat. Yum responded quickly by pulling the supplier, but last October said that companywide sales in China for the fiscal third quarter fell 14% at restaurants open at least a year. Before that, the company, which runs more than 6,000 restaurants in China, was dealing with public backlash that began in November 2012 over reported use of growth hormones and antibiotics by two KFC chicken suppliers. The company subsequently reduced its number of suppliers and apologized for "communication missteps," but said its products were safe.

Attempting a comeback, Yum's Mr. Su overhauled the KFC menu last year, adding more rice dishes, and has been remodeling restaurants. Most recently, KFC launched coffee drinks to compete with McDonald's McCafé stores. But Mr. Su has said he isn't trying to match the aspirational image that Chinese consumers once had of KFC.

McDonald's, which opened in China in 1990, is also trying tactics for renewal there, such as restaurants with Barbie and Hot Wheels themes. McDonald's Corp. declined to comment.

Loss of luster isn't confined to the fast-food chains. Wal-Mart Stores Inc. in recent years is treading water in China while domestic megamarket retailer China Resources Enterprise Ltd, which gears itself to a growing Chinese middle class, has moved ahead.

Wal-Mart's market share has stayed constant at 11.2%, while China Resources has overtaken it, going from a 9.8% share in 2009 to 13.9% in 2014, according to market-research firm Euromonitor International.

A spokesman for Wal-Mart said the comparison between the stores was unrealistic. "It is like comparing Whole Foods in the U.S. to Wal-Mart," he said.

He said the company continues to gain in all areas, including market share, but declined to give details.

Consultants say that refreshing stale brands will be challenging, but that some brands, such as Starbucks Corp. are investing frequently in remodeling their stores to stay fresh. A Starbucks spokesman declined to disclose its investment in remodeling but said that the company has overhauled stores since entering China in 1999.

"Nobody can rest on past success anymore, and companies have to keep reinventing themselves to remain relevant," said Matthew Crabbe, an Asia-Pacific research director for consultancy Mintel Group Ltd.

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